Failure to Tender Production Royalty Did Not Trigger Forfeiture Clause

In a typical oil and gas lease, there are three primary sources of compensation to the landowner: the production royalty, the delay rental and the shut-in royalty. Many older oil and gas leases also contain what is known as a forfeiture clause, which allows for the termination of the lease if certain conditions or payments are not satisfied by the gas driller. In a recent decision, the Pennsylvania Superior Court held that the failure to pay a production royalty did not trigger the lease’s forfeiture clause. The Superior Court in McCausland v. Wagner, 2013 Pa. Super. 256 (Sept 20, 2013) (No. 1186 WDA 2012), opined that, although it was undisputed that the production royalty payments were not made, the forfeiture clause was nonetheless inapplicable since there was a producing well on the leased premises. In light of the McCausland decision, landowners and gas drillers alike should carefully review their leases and the scope of any forfeiture clause.

Ronald McCausland owned a 65-acre parcel of land in Armstrong County. Pursuant to the oil and gas lease signed Feb. 4, 1964, he was to receive a royalty equal to one-sixteenth of the natural gas production. In 2009, he filed a complaint alleging that he had not been paid any production royalties since 2005, even though there was at least one producing well on the leased premises. The two-count complaint sought award of the unpaid royalties and a declaration that the 1964 lease had automatically expired and terminated pursuant to the lease’s forfeiture clause.

The parties subsequently entered into a partial settlement and McCausland received all of the unpaid royalties. The 2010 settlement agreement expressly reserved to McCausland "the right and ability to seek a judicial declaration that the … lease is null and void." Shortly thereafter, McCausland filed a motion for summary judgment on the grounds that the failure to tender any production royalty between 2005 and 2009 triggered the forfeiture clause in the 1964 lease. In ruling on the plaintiff’s motion, the trial court applied the doctrine of inconsistent remedies and opined that "when McCausland accepted the past due royalties … he elected to continue the lease" and that by doing so "he waived his right to declare the lease null and void." The trial court denied the plaintiff’s motion and granted the operator’s cross-motion and dismissed the declaratory judgment claim.

On appeal, McCausland argued that his receipt of the unpaid royalties as part of the 2010 settlement agreement did not waive his right to seek judicial cancellation of the 1964 lease. Specifically, McCausland argued that the payment breach could not be cured and that the remedy set forth in the forfeiture clause was essentially automatic and self-executing. The precise language of the forfeiture clause provided: "It is further understood and agreed by and between the parties hereto that a failure to make any one of such payments, or to complete one well on the premises, shall render this lease null and void, and the same shall be fully ended and determined by and between the parties, and lessor shall have no right, nor right of action in law and equity against lessee for the recovery of any rent, damages or otherwise thereafter."

Based on this language, McCausland contended that the 1964 lease was "null and void" upon the first missed royalty payment and that the trial court had erred by dismissing the suit under the doctrine of inconsistent remedies.

McCausland’s appeal required the Superior Court to reconcile the doctrine of inconsistent remedies with the forfeiture clause set forth in the 1964 lease. The McCausland panel noted that the doctrine is well settled in Pennsylvania and that a party generally cannot seek monetary damages owed under a contract while at the same time seeking a rescission of that same contract. The court observed that "in a breach of contract suit, the plaintiff either may rescind the contract and seek restitution or enforce the contract and recover damages based on expectation." Since the plaintiff had elected to accept the unpaid royalties, the court held that, under the doctrine of inconsistent remedies, "he essentially deprived himself of the right to declare a forfeiture" of the 1964 lease. The forfeiture clause itself, the court noted, did not change this conclusion.

Citing precedent from 1899, the McCausland court stated that it has been long established that a lessor cannot invoke a forfeiture clause in an oil and gas lease and simultaneously seek unpaid money allegedly due under that same lease. In Wheeling v. Phillips, 10 Pa. Super. 634, 637-638 (Pa. 1899), the Superior Court addressed a similar forfeiture clause in an oil and gas lease and held that: "Where there has been a default by the lessee, mere silence or inaction on the part of the lessor will not render the lease void. He may, on default, demand and compel the payments. By doing so, he elects to continue the lease. Or he may, on default made, notify the lessee that because thereof he declares a forfeiture."

Moreover, the McCausland court concluded after reviewing Wheeling and other forfeiture cases, the primary purpose of the typical forfeiture clause was to "guarantee that the lessee would develop the property" and if the lessee failed to do so, the lessor could terminate the undeveloped and nonproducing lease. The court observed that Pennsylvania has historically applied forfeiture clauses only if the lessee has failed to pay delay rentals or has failed to complete a well. As such, the instant forfeiture clause was not triggered since the lessee had actually developed the leasehold and completed a producing well. The Superior Court therefore affirmed the entry of summary judgment, concluding that the forfeiture clause did not apply to the nonpayment of production royalties.

The McCausland opinion does not break new ground and simply reaffirms a well-established precept of Pennsylvania oil and gas law regarding forfeiture clauses. As noted by the McCausland panel, Pennsylvania courts have limited the application of forfeiture clauses to instances of nondevelopment, as in Bertani v. Beck, 479 A.2d 534 (Pa. Super. 1984), where failure to pay delay rental gave rise to the automatic forfeiture of the lease; Craig v. Cosgrove, 121 A. 406 (Pa. 1923), which addressed a forfeiture clause for nonpayment of rent or for failure to fulfill a covenant to drill a well; and Wolf v. Guffey, 28 A.1117 (Pa. 1894), which addressed a forfeiture clause of a lease for failure to complete a well. Since the primary purpose of the forfeiture clause is to encourage hydrocarbon development, the presence of a completed and producing well mitigates this remedial objective. Under McCausland, the nonpayment of production royalties will not trigger such a clause since the lessee has actually engaged in hydrocarbon development. Nothing else should be read into the decision, and efforts to expand the holding to preclude other lease termination challenges are simply unwarranted.